It is hard to believe, but we are now living through it – Market is going up on free printed money; gadgets, gadgets, gadgets are everywhere; people are tricked into various social networking groups and are spied upon; families are destroyed; violence is promoted; what’s next?

Yesterday, I watched “The Boy in the Striped Pajamas” – a MUST see, if you didn’t already!

Last Friday, many of the stocks finally retreated. Even though by small amounts, the change in the direction was quite significant. What terrible things could have happened to cause it?

THE GOOD NEWS!

Unemployment unexpectedly fell down to 10%. Shouldn’t that be a happy sign celebrated by all? Well, it was… for an hour.

As an afterthought, market movers realized that the drug they enjoyed for the last few years – FREE MONEY – can be taken away. If recession is over and unemployment is improving, there is no reason to keep low interest rates. This means that the dollar will strengthen and eventually Wall Street gamblers would have to pay back a more valuable green bucks.

The current Ponzi Scheme orchestrated by Bernanke and abused by anyone who has access to liquid assets is very simple – get as much cheap money as you are allowed, pump it into the stock market, wait to make fat profits, sell the stocks and repay back the dollars that by this time might compete in value with the toilet paper.

This scheme should keep everybody happy (at least for a while) – retirees, municipalities, hedge-funds and mutual-funds whose current gains would erase all the previous losses, big players who make killing and little players who find a new hope. After all, what lamb has been sacrificed – dollar, future and morality? Not a biggie for today’s enjoyment.

Weak dollar also helps to expand export and narrow US trade deficit – let’s do it at cost to other nations. Sorry for the repetition, but wouldn’t it be beneficial for everybody to pay China’s 2 trillion dollars reserves back with the toilet paper money? It should be enough to cover the needs of 1.4 billion Chinese people. Who would say that Fed’s Chairman is not a genius?

And only a few people ask the right question – is Bernanke an idiot or a prostitute? There is no free lunch on Wall Street. Someone would have to pay. Just think of it like a swing – if you want to stop it, don’t push it in the opposite direction – try to slow it down. Obvious? Nope.

When market collapsed, did Bernanke thought of you and me, homeowners, employees, taxpayers? NO! All the money were given to the banks, so they can keep it, make easy profits and pay bonuses. This funding was not for Main street people. Fed Funds discount rate went down from 6.25% in June of 2006 to 0.5% in December of 2008. Did you get a 5.75% break on you mortgage? … Me neither.

“There is a Chinese saying that one could quench the thirst by drinking poison,” said [Andy] Xie (former Morgan Stanley chief Asian economist), who predicted in September 2006 that the U.S. economy would fall into a recession in 2008. “Bernanke seems to be prescribing exactly this to the U.S. economy. The slower Bernanke raises interest rates, the bigger the next crisis.” Read the whole article from Bloomberg News.

On Thursday, Dec 3, I was looking at the US Dollar value. PowerShares DB US Dollar Bullish Fund (Symbol: UUP) was near its all time low, barely hanging above 22. Nice, clean support area with a tight stop, thought I to myself. The risk is limited and small, the reward probability is way greater and in more significant amount… Just my type of trade.

Then, I got an e-mail: DANGER: Dollar Crash Looms, Take Action Now! It came from the Weiss Research, Inc.

From the marketing point of view the report is brilliant:“A RUN ON THE DOLLAR,”(Screams Huge Green Headline)
…WHAT WILL IT MEAN FOR YOU?

The report is written by Lee Bellinger, publisher of Independent Living, as an urgent briefing:
… Anyone holding dollars or dollar-denominated assets is sitting on a ticking time bomb, and the fuse is burning short. There isn’t a moment to lose before we see a worldwide rush to the exits…“The Dollar’s Coming “Reckoning Day”:
On a Par With Pearl Harbor and 9/11″ cries another green sub-head.
One more follows shortly thereafter:“You Must Plan for the Coming Dollar Collapse: NOW”

That definitely messes up my thinking. Now I am more concerned with the question: “Should I buy that subscription to Independent Living for $69 and receive well-promoted Dollar Destruction Defense Manual NOW, or should I use my own brain and come up with the answers first, before looking at the offered “cheat-sheet”?”

Next day, on Friday Dec. 4, Dollar posts 1.7 percent gain – the most since Jan. 20, after the Labor Department said employers cut the fewest jobs in November since the recession began.

However, missing a trade is not a big deal. What’s really got me, was the necessity to change a diaper and drive kids to school just when the news broke. Then use the cell phone on the red lights to check 20-min delayed Google quotes and wonder what numbers I’ll see on the computer screen when I finally make it back home.

If it was hard to trade with two kids, it’s pretty much impossible to do with three.

Today I noticed a very interesting phenomena. While CBOE Volatility Index $VIX.X was falling, its call options were actually rising in price.

For anyone who is somewhat familiar with the definition of calls, this would make very little sense. Call options are the financial instruments that derive their value from the underlying product. They give the right to the holder to buy underlying product at a set price (strike price). If current price of the underlying instrument is higher than the strike price, the owner can simply buy the underlying instrument at a set price and unload it at the market price. (This is very simplistic explanation and is not advisable to act upon. Options have embedded time value and should be sold, rather than executed before the expiration).

Getting back to $VIX.X – on 11/02/09 it closed at 29.78 and on 11/03/09 it closed 28.79. Meanwhile, I hold +VIXLF – VIX December Call Options with strike price 30. Yet, the price of my call option has risen to 2.45-2.55 from yesterday’s 2.35 level. How could that be?

If you received your MS from NYU Courant Institute in Math in Finance, as I did (or a similar program at a few other universities), you know the answer. If not, below it is.

Have you ever heard about Black-Scholes Option Pricing Model? For 3 semesters most of my classes were centered around this model one way, or the other. Every single interview I had on Wall Street consisted of Black-Scholes model questions.

So, what is that model? It’s like a secret soup recipe If you put bunch of ingredients in the pot and cook it, you’ll get the price of the option (soup). (SORRY, I don’t cook much, but I had so much theoretical math, that I can come up with the theories in any life dimensions). The price of the underlying instrument is just one of the ingredients; there is also time to the expiration, risk-free interest rate, strike price, volatility and the cooking procedure (functions). If you know all the ingredients you can guess how the soup will taste. If you tried the soup, you can guess the ingredients. If you put too much salt – the soup is salty, if the soup is salty, it’s fair to assume that there was too much salt put in.

Now, on the left side of the equation we have decrease in the spot price, on the right side – increase in the option price. Working back through the model, we deduce that Implied Volatility of the underlying instrument has increased. What is “Implied Volatility”? It’s market opinion about future volatility.

Let me repeat this one: In Market opinion, future volatility of the Volatility Index will increase. Or to make it digestible – market expects a big move.

Look at the following chart of Dow Jones Industrial Average:

This technical analysis may explain why even good news can’t pull DJIA higher in the last few days.

According to Elliott Wave theory, dominant trend is going in 5 waves and corrective trend in 3.

Here is a 3-yr chart of Dow Jones Industrial Average, as I see it:

If my technical analysis is correct, we are going to see a significant decline in stock prices and formation of a “double bottom”.

There is also a possibility of a different scenario: The market will continue moving up, extending the 3-wave of correction into 11,000 territory. Such move would transform the correction trend into a 3rd wave of a Bull Market.

In my opinion, the first scenario is much more likely, considering the fundamental information. Unemployment is creeping up; “affordable real estate” has definitely improved, but luxury homes are just hitting bottom and Commercial real estate is falling deeper and faster; Banks didn’t learn any lessons and are robbing taxpayers in broad daylight; dollar is week and may lose the ground; government is printing money for the wrong means…

The main question now – when would cheap as dirt money improve the economy (and create a new bubble)?

Today is Friday, the end of the week. DJ Industrial is almost 400 points up from the low of the week at 9,834. It pretty much made up for the last two weeks of losses and is in the middle of 9,800-9,900 resistance area.

Accordingly, CBOE Volatility Index $VIX.X is near its support level at 23.59.

$VIX.X 52 weeks low is 22.19 and high is 89.53.

I just bought a chunk of +VIXLF contracts, that stands for VIX Dec 30 Calls. In other words, those are Call Options on CBOE Volatility Index with strike at $30 and expiration date of December 16, 2009.

In addition to the technical analysis, there is some fundamental support for my decision, and I’ll give more details shortly.